Chapter 16 Study

What is the difference between federal government purchases (spending) and federal government expenditures?

Government purchases are included in government expenditures.

Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD1 to AD2. As a result, both price level and real GDP increased. What can be said, however, about the increase in real GDP?

It increased by less than indicated by a multiplier with a constant price level.

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.50, calculate the value of the following multipliers. Be sure to use a negative sign to show if a multiplier has a negative value. To calculate the government purchases multiplier, divide 1 by (1 - MPC). To calculate the value of the tax multiplier, use the formula: - MPC / 1 - MPC

The government multiplier equals 2 The tax multiplier equals -1 The balanced budget multiplier equals 1

If Congress passed a one - time tax cut in order to stimulate the economy in 2014, and tax rate levels returned to their pre - 2014 level in 2015, how should this tax cut affect the economy?

The tax cut would increase consumption spending less than would a permanent tax cut.

When is it considered "good policy" for the government to run a budget deficit?

When borrowing is used for long-lived capital goods.

Does government spending ever reduce private spending?

Yes, due to crowding out

In the long run, increases in government purchases result in

complete crowding out.

As a result of crowding out in the short run, the effect on real GDP of an increase in government spending is often

less than the increase in government spending

Suppose real GDP is $12.6 trillion. To move the economy back to potential GDP, Congress should

lower taxes by an amount less than $500 billion.

According to the multiplier effect, an initial increase in government purchases increases real GDP by ___ the initial increase in government purchases.

more than

From an understanding of the multiplier process, explain why an increase in the tax rate would decrease the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier Similarly explain why a decrease in the marginal propensity to import would increase the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier the denominator is

the MPC is multiplied by (1-t) 1-[MPCx(1-t)-MPI]

The figure to the right illustrates the dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). We would expect the federal government to pursue what type of policy in order to move AD2 to AD2policy and reach equilibrium (point C) in the second period? If the federal government's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP ___ Potential real GDP ___ Price level ___ Unemployment ___

Expansionary fiscal policy increases does not change increases decreases

The figure to the right illustrates the dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). What policy would the federal government likely pursue in order to move AD2 to AD2policy and reach equilibrium (point C) in the second period?

Increase government spending

Problem, Policy, Actions, Result

Recession, Expansionary, Increase government spending or Decrease taxes, Real GDP and price level rise Rising inflation, Contractionary, Decrease government spending or Increase taxes, Real GDP and price level fall

If the marginal propensity to consume equals 0.80, the tax rate equals 0.20, and the marginal propensity to import equals 0.02, what is the value of the government purchases multiplier? The formula for the multiplier is now: 1 / 1 - [ MPC ( 1 - t ) - MPI] 1 / 1 - [ .8 ( 1 - .2 ) - .2]

The government purchases multiplier is equal to 1.79

The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06, we would expect the federal government to pursue a ___ fiscal policy. If the government's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Actual real GDP ___ Potential real GDP ___ Price level ___ Unemployment ___

contractionary decreases does not change decreases increases

One-time tax rebates, such as those in 2001 and 2008, increase consumption spending by less than a permanent tax cut because one-time tax rebates increase

current income

If government purchases increase by $100 billion and lead to an ultimate increase in aggregate demand as shown in the graph to the right, the difference in real GDP between point A and point B will be

more than $100 billion

Policy that is specifically designed to affect aggregate supply and increase incentives to work, save, and start a business, by reducing the tax wedge is called

supply-side economics

Increased government debt can lead to higher interest rates and, as a result, crowding out of private investment spending. In terms of borrowing (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the economy?

All of the above; Debt-spending on highways and ports, research and development, education

How does a budget deficit act as an automatic stabilizer and reduce the severity of a recession?

All of the above; During recessions, tax obligations fall due to falling wages and profits. Consumers spend more than they would in the abscense of social insurance programs, like unemployment. Transfer payments to households increase.

What are the gains to be had from simplifying the tax code?

All of the above; Resources from the tax preparation industry freed up for other endeavors. Increased efficiency of households and firms. Greater clarity of the decisions made by households and firms.

After September 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal policy?

No. The increase in defense spending after that date was designed to achieve homeland security objectives.